1. Drawing diagram explain the process of “crowding out”. Also explain why the private sector might find budget deficit detrimental to their business planned projects.2. “Increase in net capital inflow will increase interest rates in the domestic loanable funds market” – do you agree with this statement? Explain by drawing a diagram and comment how you think investment will change if there is an increase in capital inflow.
Crowding out: Crowding out occurs when the expansionary fiscal policy of the government reduces the investment spending of the private sector. To carry out the expansionary fiscal policy the government needs funds. The government increases its demand for funds in the loanable funds market. As a result, the funds available for the private sector decrease, and the banks increase the interest rate. It leads to a decrease in the private sector investment spending. Or it can be said that the government spending crowds out the private sector spending.
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